Ebadi, 56, one of the first female judges in Iran and who was jailed on charges of slandering government officials, has worked actively to promote peaceful, democratic solutions in the struggle for human rights, the Norwegian Nobel Committee said.
It added that she is well-known and admired by Iranians for her defense in court of victims of attacks by hard-liners on freedom of speech and political freedom. The news, which made headlines around the world, was not reported immediately on Iran's state-run media.
"As a lawyer, judge, lecturer, writer and activist, she has spoken out clearly and strongly in her country, Iran, far beyond its borders," the awards committee said in its citation.
It said she has stood up as a "sound professional, a courageous person, and has never heeded the threat to her own safety."
"I am extremely happy. This is a great day for reformers in Iran. It's great for her and great for the country," her husband, Javad Tavassolian, said from Tehran, where she was expected to return from Paris next week.
Anthropologist Ziba Mir Hosseini of London University knows Ebadi well, and has worked with her on family law issues in Iran. She told CBS News Correspondent Steve Holt the award will give Ebadi confidence.
"It will also somehow make her somehow more secure in the context (of the) politics of Iran," Hosseini said.
Ebadi, who is often sharply criticized by hard-liners and conservative clerics, was arrested in 2000, spent about three weeks in jail after a closed trial, and given a suspended sentence. Ebadi was banned from working as lawyer for five years. It was unclear whether the ban was still in effect.
"I'm a Muslim, so you can be a Muslim and support democracy," Ebadi told Norwegian television when reached in Paris after winning the prize. "It's very good for human rights in Iran, especially for children's rights in Iran. I hope I can be useful."
This year's prize is worth $1.3 million.
Ebadi, who also is known for her writings, was Iran's first female judge, her husband said, and served as president of the city court of Tehran from 1975-1979. Forced to step down as a judge after the Islamic Revolution in 1979, she has since been an activist for democracy and the rights of refugees, women and children.
As an attorney, she represented families of writers and intellectuals killed in 1999 and 2000, and worked to expose conspirators behind an attack by pro-clergy assailants on students at Tehran University in 1999.
She is the third Muslim to win the prize. Yasser Arafat won the prize in 1994, sharing it with Israeli Foreign Minister Shimon Peres and slain Prime Minister Yitzhak Rabin. In 1978, Egyptian President Anwar Sadat shared the prize with Israeli Prime Minister Menachem Begin for jointly negotiating peace between the two countries.
The decision was hailed by human rights activists around the world.
"By honoring Shirin, the Norwegian Nobel Committee has recognized the critical importance of human rights and the individuals who defend them around the world," Amnesty International said.
Austrian Foreign Minister Benita Ferrero-Waldner praised Ebadi as "a courageous woman who has earned the support of all women in the Western world."
Former Czech President Vaclav Havel sent his congratulations through his secretary, Jakub Hladik, who said "he judges that she certainly deserves it."
"It's a great victory for Iran, for human rights militants in Iran, for Iranian democrats in Iran," said Karim Lahidji, president in exile of the Iranian League for Human Rights and vice president of the Paris-based International Federation of Human Rights Leagues.
"Shirin Ebadi spent 25 years of her life so that rights reign in Iran," said Lahidji, a friend for 40 years.
In Beirut, human rights activist Samira Trad said the Nobel committee "has made a good judgment. It is good for a woman and good for our area."
Jordanian human rights activist Rana Husseini called it "a great achievement."
"I think this will promote women's causes worldwide including Arab and Muslim women's issues," Husseini said.
Committee chairman Ole Danbolt Mjoes said Ebadi's work in human rights made it an easy decision.
"This is a question of fundamental rights about women, about fundamental rights of children and mothers," he said. "I hope the award of the peace to Ebadi can help strengthen and lend support to the cause of human rights in Iran."
The committee also lauded Ebadi for arguing for a new interpretation of Islamic law that is in harmony with vital human rights such as democracy, equality before the law.
The medicine, physics, chemistry, literature and peace prizes were first awarded in 1901.
The secretive five-member awards committee, which is appointed by but does not answer to Norway's parliament, makes its choices in strict secrecy. It also keeps the names of candidates, a record 165 this year, secret for 50 years, although those who make nominations often reveal them.
Speculation this year had centered on Pope John Paul II and former Czech president Vaclav Havel.
In Poland, Solidarity founder Lech Walesa, the 1983 Peace Prize winner, expressed disappointment that John Paul didn't receive the award.
"I bear nothing against this lady, but if anyone among the living deserves it then it is the holy father," Walesa told TVN24.